For the year, the S&P 500 logged a total return of 28.7%, while the NASDAQ rose 22.2% and the Dow Composite ended 2021 up 23.57%. Overall it was a great year in the stock market. To put the year in perspective, the S&P 500 falls by 10% or more every 11 months on average, but in 2021 the S&P 500 never had a drawdown of more than 5.5% off of it’s highs. Steady returns and low volatility made for a positive year for most investors.
It wasn’t all fun and games for everyone, however. As you can see below, some of our favorite stocks, what we consider the companies of the future had significant declines in value from their highs. Sector rotations really hit the high growth equity markets, especially in tech. Some of these companies are more than 80% off their highs today.
So why would these companies take such massive hits in valuation? Tech stocks are particularly sensitive to interest rate changes because of the discounted cash flow (DCF) models used to value them. The discount factor, which represents borrowing costs, or interest rates in the economy, lowers the present value of future earnings. When stocks are valued heavily on expected growth of future earnings, they will be impacted more by rising rates that companies that are not. Tech stocks are the companies of the future, and for this reason they are valued heavily on future earning expectations and the growth of those earnings. Thus, anticipated interest rate changes can have a significant impact of their present valuations, right or wrong. For long-term investments, we think this is short-sighted pricing and it offers ample opportunity to buy into these companies at lower prices. If you are a short-term investor (trader), you may not feel this way. As the correction continues to fall into 2022, we feel very positive about the long-term outlook of many of these companies.
Speaking of interest rates, we track the 10-year treasury rates the most closely. After the yields fell to a historical low in 2020 they seemed to stabilize in 2021. With the Fed warning of future rate increases over 2022 and beyond to off-set inflation we should see these yields continue to rise slowly.
This may continue to have a negative impact on bond yields in the short term, but it should work itself out in the long run.
As far as inflation goes, 40% of the money supply currently circulating in the economy is money that has been artificially injected into the economy over just the past 2 years. It’s no secret that this can cause significant reactionary inflation, and as the economy has recovered, that is what’s happened. CPI was last valued at 7.04%, and many of us feel it’s been significantly higher. This doesn’t mean that this will continue, however, as many speculate deflation could be on the horizon as things normalize.
As you can see from the interest rate conversation, The ratio of the 10 year treasury yield – the US CPI has gone to it’s lowest amount in 50 years, which will encourage the Fed to raise rates in the future. Much of this data is what is factoring into the forward looking markets and current market declines.
One of the hottest topics over the past 5 years has been crypto currency and it’s place among investor asset allocations over the next decade. As investors and advisors we track Bitcoin and Ethereum the closest. 3 weeks into 2022 both coins are down over 30% from the end of year prices in 2021, but their growth has still been significant and they have solidified their place as a potential long-term asset class for investors. Arbor will continue to explore ways to potentially add exposure to these asset classes for investors in the future, along with analyzing the volatility and stability of digital assets.
Lastly, a year review wouldn’t be complete without talking about real estate. Home values in 2021 continued to sky-rocket. The Case -Schiller Composite is up over 18% in 2021. US inventory continues to fall despite the US population continuing to increase. A good result for investors that own more than 1 home, but a difficult situation for 1st time home buyers. As we see interest rates start to rise, we should see softening of prices (lagging the rate hikes), but if inventory doesn’t normalize over time, we may continue to see increases in values despite increases in rates.
Questions on any of these charts or topics? Contact us through arbofirm.com.